One of the benefits touted by loan consolidators is that the interest paid on home equity loans is tax deductible. The first thing to consider is if you itemize your deductions. If you don’t itemize your deductions then the deduction for a home equity loan won’t be added in.
If you know you're going to itemize, then take a look at the limits on home equity deductions.
All of the interest on your first mortgage is tax deductible, up to $1 million for a couple filing jointly, $500,000 for a single person or a married person filing singly. However, it’s only deductible if you use the money for financing a home or for improvements that will substantially improve the house.
The test for “substantially improve” is that it adds to the value of your home or prolongs the useful life or your home, or adapts your home to new uses. Painting your house to keep it in good condition is not considered a substantial improvement but if that same paint job is part of a bigger remodel job, then it is considered a substantial improvement.
With second mortgages, the rules change. You can only deduct the interest up to $100,000 in home equity debt. The debt must be secured by your home equity. If, for example, you take out a home equity loan for more than the value of the house then only part of that is considered “secured” by your home equity. The amount over and above the amount secured by your home is considered a personal, unsecured loan and the interest is not deductible.
Unlike first mortgages, it doesn’t matter what you use the money from a second mortgage for. So if you use the money from a second mortgage for school tuition, it’s still tax deducible.
Other items related to your mortgage and home equity loans are also tax deductible. If you paid points, that can be deducible but there are special rules that govern when you can take the deduction. Any penalties you pay can also be deductible. It’s always a good idea to check on the rules in a given year. Tax software is generally very good at keeping up on the rules for these types of deductions and can step you through.
Don’t count on the interest deduction when you sign a loan. The loan officer might not know all the rules. Check with a tax professional if you are counting on the tax deductibility.
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